Hidden Attorneys’ Fees in Contracts

Think There is No Attorneys’ Fees Clause in Your Contract? It May Be Hidden in the Performance Bond

By Sean Thompson and John Klotsche, Hanson Bridgett LLP

In California, a litigant is only entitled to recover attorneys’ fees if a statute or contract allows such recovery. As a result, one of the most important provisions in any construction contract is the attorneys’ fees clause.

Most attorneys’ fees clauses provide that the prevailing party in dispute resolution proceedings will be entitled to recover its attorneys’ fees incurred in enforcing the contract. However, even if the attorneys’ fees provision states that only one party is entitled to fees, California Civil Code § 1717 mandates that the clause be applied reciprocally, providing either party the right to attorneys’ fees if it prevails in a dispute on the contract.

Fees Clause Can Affect Outcome

The presence of an attorneys’ fees clause can significantly affect the course and out-come of disputes arising from a construction project.

Conventional wisdom says that an attorneys’ fees provision is more likely to benefit a downstream party in a construction contract. For example, a contractor seeking unpaid amounts from an owner is likely to benefit from the existence of an attorneys’ fees provision. This is because, in the event of a dispute, the owner has the ability to withhold funds from the contractor, which usually forces the contractor to resort to litigation to get paid.

Because attorneys’ fees accrue to the “prevailing party,” the contractor may be more likely to get attorneys’ fees since the contractor generally only needs to achieve a “net monetary recovery” to be considered the prevailing party. The same logic holds true if the scenario is a subcontractor versus a general contractor. Since the general contractor has control over the flow of funds to the subcontractor, the sub is more likely to resort to filing suit and also more likely to be the prevailing party. Because of this dynamic, upstream parties may exclude attorneys’ fees clauses from their construction contracts to diminish the likelihood of litigation.

Most Contracts Incorporate Performance Bond

Even if there is no attorneys’ fees provision in the body of the construction contract, most contracts incorporate, by reference, the contractor’s performance bond, which, under California law, causes the bond to be deemed a part of the construction contract. King v. Larsen Realty, Inc.,

121 Cal.App.3d 349,357 (1981).

Incorporating the bond into the contract is significant if, as is often the case, a bond requires the surety to pay the owner’s attorney’s fees arising from the contractor’s breach of contract. The practical effect is that the contract (which, by law, includes the terms of the incorporated bond) purports to give only the owner a right to recover attorneys’ fees. However, as discussed above, Civil Code §1717 renders that one-sided attorneys’ fees clause mutual and, as a consequence, gives the contractor a basis to recover its attorneys’ fees from the owner.

Contractors should anticipate that owners may vehemently contest any attempt to recover attorneys’ fees based on the terms of an incorporated bond. In doing so, an owner may point to the following language that is commonly used in such bonds: the “surety shall pay” the owner’s attorneys’ fees.

In light of this language, the owner may contend that the bond’s fee provision only affects the surety and, therefore, only the owner and surety may benefit from the fee clause. This contention should fail because it incorrectly presumes that the contractor is not liable for the owner’s attorneys’ fees. Under well-settled California surety law, the contractor, as the principal on the bond, is liable to the owner for those fees. See Cal. Code Civ. Proc. (“CCP”) §§ 996.410, 996.430 and 996.460; see also CCP § 2847.

Another problematic phrase that is commonly included in a performance bond and that an owner may use to challenge a contractor’s claim for attorneys’ fees is as follows: the owner can recover its attorneys’ fees “if suit is brought upon the bond.” Based on this language, an owner may argue that there must be an actual cause of action against the bond for the contractor to benefit from the bond’s attorneys’ fee provision.

This argument should fail so long as the contractor was not represented by counsel when negotiating the contract, which will usually be the case in hard-bid public works contracts. This is because of a 1983 amendment to Civil Code § 1717, which provides that the attorneys’ fees provision applies “to the entire contract, unless each party was represented by counsel in the negotiation and execution of the contract and the fact of that representation is specified in the contract.” Civ. Code § 1717(a)

Put another way, when a contract contains an attorneys’ fees clause, the clause applies to all aspect of the contract. Thus it allows a prevailing party to recover its attorneys’ fees arising from any action on the contract, despite language that purports to limit the recovery of fees to a specific type of action (e.g., actions “brought upon the bond”). See Harbor View Hills Community Association v. Torley, 5 Cal. App.4th 343 (1992).

Although the Voskanian and Mepco cases involved situations where there was a claim on the performance bond, El Dorado Irrigation District v. Traylor Bros., Inc., 2007 U.S. Dist. LEXIS 14440 (2007) reached the same result when there was no claim on the performance bond.

The take-away from these cases is that the presence of an attorneys’ fees clause in a performance bond may provide a contractor or subcontractor with unexpected leverage in a project dispute.

Though beyond our scope here, there are procedures that upstream parties can employ to minimize the risk that the party seeking money will be the prevailing party, such as issuing statutory offers to compromise (aka “998 offers”).